Two Similarities and One Important Difference

By TAN Kee Wee

(MediaCorp 938LIVE’s Money Talks, Thursday, 9 October 2008, 7.50 am and 7.20 pm)

When a person collapses and dies, we gather around to say the good that he has done. For some, chanting is practised. The idea is not only to ease the passage of the dead man’s spirit into the next world, it’s also to relieve the anxieties and fears of those still living.

The financial world is no different. There is also the belief in chanting whenever stock markets collapse. The idea is to get global leaders to repeat, as firmly as possible, that the spirit of the dead stock market will not haunt the economy.

Two Mondays ago, on 29 September, the Dow Jones Index suffered its biggest point drop in history, closing down nearly 800 points. That was after the US Congress voted against the Bailout Plan.

That collapse is significant because it changed the mindset of investors from “bullish” to “bearish”. In other words, global stock markets collapsed and died on 29 September 2008.

It will go down in history as the Black Monday of the 21st Century Crash. It is as significant as the last crash of the 20th century, namely the 1929 Wall Street Crash.

There are many similarities and differences between these two stock market crashes. But two similarities and one important difference stand out.

The first similarity is the easy availability of credit, combined with margin financing. In the 1920s, money and margin were also available. In 1927, this flow of easy money became a torrent after the US Fed lowered interest rates.

It was an attempt to help the weak British economy suffering under the Gold Standard. It was also hoped that the torrent of newly-created money would flow into the US economy. Instead, the money found its way into Wall Street.

The second similarity between 1929 and today is the existence of a financial house of cards. Today, our house of cards is built up on US sub-prime loans and exotic investment products.

In the 1920s, the financial house of cards was built up by the holding companies. These were companies formed to invest in other companies. And the companies they invested, invested in yet other companies that, in turn, invested in yet others.

All went well until cracks appeared in March 1929. But this was quickly dismissed and stocks surged higher throughout the summer. The real damage surfaced in late October, reaching a climax on Tuesday 29 October 1929.

On that day, the mood turned extremely bearish, triggering the great unrestrained rush to sell. Investors did not know what hit them, only that they had been ruined or would soon be ruined.

Following that disastrous day, there were occasional stock market rallies. But prices continued to fall in the following three years. The Wall Street Crash of 1929 led to the global banking collapse, which, together with faulty government policies, led to the Great Depression of the 1930s.

Now we come to the one important difference between today’s stock market collapse and that in 1929. This is Ben Bernanke, the Chairman of the US Fed who is an expert on financial crises. Because of that, we’re all hoping that he will be our saviour.

His job is not easy. Just because certain policies have worked in the past does not mean that they will work this time round. The US$700 billion Bailout Plan was supposed to restore confidence and unblock the credit markets.

But so far, it has done no such thing. Financial institutions continue to mistrust each other because all continue to hide their toxic secrets. In the 1930s, it was also like that.

This climate of mistrust is very much like the one we faced during the SARS epidemic in 2003, when all of us stayed at home out of fear. In reality, the situation might not be that bad. But no one knows. Ben Bernanke must therefore force these financial institutions to reveal their toxic secrets.

Until we have this knowledge, global leaders will have to resort to more chanting to frighten away the bad vibes. After all, for chanting to be effective, it’s not necessary to have any knowledge.